Milking the public

Australia’s second largest grocery chain, Coles, has come under criticism from farmer groups and their political representatives over its cut to milk prices. Coles has cut its milk price to $1 per litre. Farmer groups contend that Coles is making a loss at this price and therefore it is conducting a form of predatory pricing. The Farmer groups want the Australian Competition and Consumer Commission to open an inquiry into Coles’s milk pricing strategy.

In response, the managing director of Coles Supermarkets, Ian McLeod, made the following points in an opinion piece in the AFR today:

1. Most of the milk produced in Australia is exported;

2. The price of milk received at the farm gate has risen by 22% in the last year;

3. Coles has not lowered the price paid to the milk processing companies that buy the milk from the farm gate; and

4. More than one half of Australian families earn less than the average wage (the article actually says that).

The last point is good for a laugh; but the others, if they can be taken on face value make me wonder what farmer groups are complaining about. Presumably dairy farmers are worried about two things. First, that smaller grocery firms will be forced to cut their milk prices and will be forced to pass those cuts onto farmers. Second, that Coles (and its bigger competitor Woolworths) will eventually force cuts onto the milk processors who will force them onto farmers. Or, perhaps they are not worried about anything, but complain about their circumstances in a purely reflexive, Pavlovian, manner.

Their concerns would be a legitimate if farmers could not exit the industry and had no other market for their milk. But, if McLeod is correct, then Australian farmers send most of their milk to the international market. Doesn’t that mean that if domestic prices fall then farmers can sell into the international market? Not if domestic prices are a lot higher than export prices. But if domestic prices are a lot higher than international prices then why aren’t we importing milk, from New Zealand for instance?

Julia Gillard was in New Zealand last week. I hope the subject of New Zealand dairy imports into Australia was discussed extensively.

Clearly point #4 is possible when there are extremely rich outliers that raise the average above the median.
Also, I think the main argument here is that milk prices have risen 22% in the last year and no good reasons for that are given in the article. I assume that Coles is making a stand to try and lower the prices by using their market force (Walmart does the same thing).

Dairy farmers are a funny lot, after being paid $1.8B compensation for having to enter the free market they are now complaining that prices are not fair. The reality is that it is other farmers that they are competing against, prices reflect supply. A lot of them want to live the lifestyle of their grandparents, pottering along with the cows and the chooks.

The real point that is getting missed here is the absent voice of the ‘milk processors’ from the press realeases. They do nothing to justify rises in milk contracts to the major retailers and squezze the dairy farmers, I guess that Coles have just got fed up with the middle man ‘milking’ the industry at both ends of the chain. Lets get a comment from Nation Foods who is the main supplier of brand milk to Coles

There appears to be an implicit assumption – from the farmers and also from some of the commenters above – that lowering the retail price will lead to some pressure to reduce costs upstream. But, of course, it does just the opposite. At lower prices, demand will increase and this will cause costs to increase (assuming that supply curves are upward sloping, although they may be fairly flat if most milk is exported).
It is the classical fallacy in reverse: prices are driven by costs, so if price is reduced then costs must fall.

I believe the contract price that the supermarkets pay the producers is coming up for renegotiation next year. This is probably where the fear factor comes in for the farmers. (One of my colleagues comes from a dairy-farming family and their fear is loss of lifestyle and a diminished township. Probably a common enough perception amongst farmers involved in producing commodity goods.)

@Dave,
Apparently (based on a Senate enquiry 2010 on milk pricing) milk demand is mostly inelastic in that the overall domestic demand doesn’t change much even if people rush to the supermarkets in question to take adavntage of low sale prices. (Involves transferring the point of sale rather than expanding the market.)

“the mean equivalised disposable household income of all households in Australia in 2007-08 was $811 per week, the median (i.e. the midpoint when all people are ranked in ascending order of income) was somewhat lower at $692 ”

Apparently drinking milk accounts for around 20% of production with the rest going into manufacturing (mainly cheese and milk powder). Traditionally the drinking market offered a substantially elevated price to farmers, supported by a complex set of market restrictions and production quotas. The market deregulation that has occurred over the last few years was aiming at abolishing the drinking milk restrictions so that price would become aligned with the global milk price.

The milk processors are between a rock and a hard place, in that if they don’t meet the market price they don’t get to buy milk from farmers, but Coles & Woolies can put serious pressure on their margins.

Mike Pone is dead right. In fact the log-normal shape of the income distribution means that about 60-65% of people are are below average income. For wealth, it’s something like 75% are below average. There’s a difference between “median” and “average”.

The statement that ‘More than one half of Australian families earn less than the average wage’ is good for a laugh because it is presented as being profound when really it is trivially obvious. Incomes must, as a practical matter, be skewed to the right because they are unbounded above so the average exceeds the medium.

McLeod’s comments cannot be taken a face value. To being with, the majority of Australia’s milk is not exported. Exports currently stand at around 45% and virtually none of it is actual milk, it has been converted to milk powder or cheese.
But the key point that Coles conveniently ignores is that is the industry is geographically distinct. Almost all the exports come from Victoria. In Queensland 95% of production is for the drinking milk market. In NSW and WA around 75%. In these regions supermarket pricing behaviour has a major influence on farmgate prices.
Regardless of whether Coles sticks to its claim it will not reduce wholesale price of its private label contracts, Coles will still impact processor and farmer returns by reducing market share of higher-value branded milk. They are also pushing out non-supermarket sales, which again tend to be higher margin.
Australia isn’t importing large volumes of milk from New Zealand because of the costs associated with moving what is mostly water and the perishability of the product. We do import UHT milk from New Zealand.

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